Reading the Breadth Map

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  • on October 6th, 2012

“What was the criteria in selecting a certain cache of data to focus on over all of the other available data?” Josh Brown

He wasn’t asking me, but this post of his came out while I was pondering Part 2 in a series explaining why and how I use data on market breadth. It would be hard to think of a more discerning skeptic than Josh, which is why we all enjoy his wit and wisdom. I loved his post, as I am a huge believer in the JM Keynes line “It is better to be roughly right than precisely wrong“.  There is so much BS slung around on Wall Street to rationalize opinions, with confirmation bias ruling the day.

Which brings me to my use of market breadth, and my, ahem, precise measurement of it. As I see it, it’s useless to know that 70% of active stocks are above their 10 day moving average. Without asking important contextual questions, 70% is just a number…and one that can be good or bad. What if yesterday’s reading was 75%? What if the % above their 13 day average is 77%? What if the last time $SPX was at this level the number was 85%? In those cases, the number 70% represents a contraction in market breadth; not a time to expect large cap breakouts to stick.

So what’s important is not just the level, not just the direction, not just the momentum. To make this data useful, we need a map that prioritizes and categorizes it into a useful checklist and action plan. The graphic in the last post showed how I organize the data; the following shows the order in which I review it:

It looks like an endless checklist but for me, it’s just a simple list of relevant data points leading to a decision on my market bias. I don’t go through every item and give an overall score; that’s called paralysis by analysis and also fails to isolate the market’s presently dominant timeframe. Instead, I start at the upper left(Short-term Momentum) and “score” each section until the bias is clear. If the readings in the Short-term Momentum section give me a clear buy or sell bias, I don’t need to drop down to the Short-term Direction section. But if those sections reveal nothing but sideways breadth, I drop to Short-term Levels to see if the readings indicate a robust(perhaps resting) one-way trend waiting for a chance to continue. Still nothing, then to the top middle for IT Momentum and on until I have my answer.

I had highlighted just a couple of items in my last post, in order to keep it simple. First, that September 6 was a significant launch point for the bulls(obvious with or without my help). Second, that the rally brought us into extreme intermediate-term levels on September 14 that indicated limited upside. I navigate this breadth work on the assumption that higher is better, until “better” runs out of room to get even more better.

Since I view trends as a constant battle between doubt and belief, when my numbers push 95%(or 5% the other way) it shows a market that has abandoned prudence and is in chase mode. As Brian Shannon often reminds us, a) “Where has it come from?” b) “Where does it have the potential to go?”. In this approach I’m generally focused on the path and not the end, but “Slow” readings that reach 95% and 5% participation are big stop signs in my work that tell me to stop expecting more of the same.

Now? A “market of stocks” that began deteriorating on September 17,and stayed pretty anti-bull until the 28th. Not much of a price correction, but 9 trading days in which upside breakouts were thwarted in favor of rotation. After that point, the climate stopped getting worse and long swings could be considered. Here’s a look at the data through Friday, with the left sets of columns representing short-term and the right representing intermediate-term:

Looking out at the broader context, my interpretation of the breadth map says expecting an intermediate-term breakout was(and still is) an unreasonable expectation. Starting on September 17, the daily readings(right 1/2 of the page) have stayed in a firm pattern of fast<mid<slow, across all of the categories shown. That wasn’t enough to keep me from joining the upswing, but I’ve considered any longs to be of the days variety, not weeks or months. Some can spot that better on a chart of $SPX, but in my case I’m not sure I’d have felt as comfortable making that judgment. This gives me a sample size of 400 charts every time I make a decision on $SPY; those composite odds work better for me. Equities are the only tradeable market offering this ability to dissect the components, and the reason I stick with equity indices instead of trying my hand in other markets using an inferior toolkit.

I’m not a day trader, but on the day of entry or exit don’t we all want great trade location? I know fundamental investors are too smart for all of this, as they believe today’s ignorant fools will soon realize the mistake they’re making by giving their stock away today. But doesn’t it help to consider how many market “fools” have acted, and whether their foolish movement is gaining or losing members? Macro does matter, and lacking the crystal ball to predict global risk appetite leaves market breadth as my best measure of whether investment dollars are coming or going. Its my way of hearing the message of the markets without relying on any one chart, a combination of depth and simplicity I prefer in order to act with confidence.


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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